How can you avoid an IHT ‘minefield’ if you remarry?
Marriage rates among the over 50s have risen significantly in recent years, according to the Office for National Statistics (ONS). Latest data reveals the number of men who said ‘I do’ aged 50+ is up by 33% in the past decade; for women in that age group it’s even higher, at 47%.
Those figures are greater still for people in their 60s, where there’s been a 33% increase in men who have married aged 60+ and a 56% rise among women over the 10 years to 2022.
Later-life marriages – whether people’s first, second or subsequent – often come with children on at least one side. Estimates vary but based on ONS figures, somewhere between 10% and 33% of families in the UK are blended, which the ONS defines as at least one child having a parental relationship with both members of the couple and another child being a stepchild.
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Blended families can bring complications, whether around presents or planning holidays. But what happens when the stakes are higher?
If you’re widowed or divorced and have found love again, the last thing you might want is to start thinking about the end. Yet imminent inheritance tax (IHT) rule changes mean more families may need to do exactly that.
As announced in the 2024 Budget, from April 2027, defined contribution (DC) pensions will be treated as part of an estate for IHT purposes. The change is expected to double the number of estates liable for IHT to around 8%.
For people with children from a previous marriage, it’s a reminder of the importance of planning ahead. A common piece of advice is to think about what you want to happen after you die as early as possible. When everyone’s healthy and getting along, emotions are steadier and discussions tend to be easier. Once circumstances change, those conversations can become more difficult.
What myths and misconceptions do people have about estate planning?
Many people still assume estate planning is only relevant to the very wealthy. Yet rising house prices, combined with the nil-rate band (NRB) being frozen at £325,000 since 2009, have brought more families into scope for inheritance tax.
Other common misconceptions include believing a spouse automatically inherits everything if someone dies intestate (without a will), that pension benefits automatically fall to family members, or that unmarried couples have the same legal protections as married couples.
Add in the complexities of blended families, differing financial needs and the pension changes and the value of clearly documenting your wishes is emphasised.
How do trusts fit into estate planning?
Trusts are often used to provide control over how assets are passed on.
Every trust has three key parties: a settlor, who provides the assets; the trustee, who manages them; and the beneficiaries, who ultimately benefit from them.
Assets that can be placed into trust include cash, property, investments and land.
In the UK, there are several different trust structures available.
Lifetime trusts take effect immediately and include arrangements such as bare trusts, vulnerable person’s trusts and personal injury trusts.
Will trusts are created through a will and only take effect on death. Examples include discretionary will trusts or pilot trusts, which can hold assets such as pension death benefits or life insurance payouts.
Interest in possession trusts, often known as life interest trusts, allow a surviving spouse to benefit from an asset during their lifetime without owning it outright. For example, they might have the right to live in a property or receive investment income, while the underlying capital eventually passes to your children or other beneficiaries.
Discretionary trusts offer trustees broad control over how and when assets are distributed. Provided the settlor lives for seven years after making the transfer, assets can fall outside their estate for IHT purposes, although periodic trust charges (typically every 10 years) may still apply.
Who to name as a beneficiary
Andrew Zanelli, head of technical engagement at investment platform Aberdeen Adviser warns of a potential “nomination minefield” once pensions become subject to IHT.
For blended families, the key question may be whether pension assets should pass to a surviving spouse or directly to children from a previous relationship.
You can see the attraction of leaving everything to a husband or wife. Pension wealth passing directly to a surviving spouse or civil partner benefits from the ‘interspousal exemption’ and is not subject to IHT on first death.
That exemption doesn’t just apply to the NRB but an additional residential nil rate band (RNRB), which is currently £175,000. This means a husband or wife could potentially pass on up to £1 million with no IHT consideration.
The challenge is what happens later.
The hope is that if everything passes to the spouse on first death, when they die, they would direct everything as intended – such as to the first spouse’s children or other named beneficiaries. But circumstances can change.
Zanelli shares an example: “The main issue here is the potential for the children of the first to die to be disinherited. Let’s assume the husband dies first. By nominating his wife, he is effectively handing over future control of his pension pot to her. She could change her nominations at any time in favour of other individuals, cutting out his own children. This could be motivated by remarrying someone else, or falling out with his children.”
Leaving assets directly to children presents a different problem. Any amount above available allowances may attract IHT immediately, plus the surviving spouse may have no access to those funds if they need them.
If you’re trying to look after your surviving spouse but want to commit something for your children, Zanelli says you can gain peace of mind by setting up a structure where your spouse is looked after for life – even through they don’t own the asset – and ultimately your children will be the recipients of any capital that’s left.
These trust structures could take several forms, including a discretionary will trust, life interest or spousal bypass trust.
What are bypass trusts?
Historically, spousal bypass trusts have been used to balance support for a surviving spouse and protecting assets for children from previous relationships.
Whether they remain popular beyond April remains up for debate.
Dan Blandford, chartered financial planner at The Private Office (TPO), believes two broad approaches may emerge.
The first is that people may stop using bypass trusts altogether and instead leave assets directly to a spouse, taking advantage of the IHT exemption and trusting them to pass wealth to the intended beneficiaries later.
This may prove attractive for families looking to avoid an immediate IHT charge, although it relies heavily on the surviving spouse ultimately carrying out those wishes.
The second scenario he foresees is more likely among wealthier families with very large pensions expected to support several generations.
Rather than allowing pension wealth to pass down through successive estates and potentially attract IHT multiple times, some may choose to pay the tax once and move assets into a discretionary trust structure.
“I envisage that would be the second reason it will be used; do people accept a ‘one-off’ IHT charge in exchange for avoiding repeated charges as wealth passes from one generation to the next,” says Blandford.
But he believes spousal bypass trusts will still have an important role for those motivated primarily by control rather than tax savings.
For those conscious of inheritance tax and retaining oversight of family wealth, these trusts allow them to determine when assets or income are distributed and help protect beneficiaries from risks such as divorce or financial difficulties.
At the same time, he expects more people to draw pension assets during their lifetime, reducing the size of the pension pot potentially exposed to IHT.
The importance of reviewing a will
Estate planning concerns are not unique to pensions.
Tamsin Caine, director of financial planning at Smart Financial, points to the example of a life interest trust involving the family home. A surviving spouse may retain the right to live in the property for life, while the deceased’s spouse’s share ultimately passes to their children.
To achieve this, the property generally needs to be owned as tenants in common. Otherwise, ownership passes automatically to the surviving spouse, bypassing the will altogether.
Caine says careful drafting and regular reviews are essential.
“It’s important to revisit wills and keep them up to date, making sure they’re still in line with wishes, with legislation and that they still reflect everything that you’d want.”
She also cautions against viewing pensions primarily as an IHT planning tool.
“Pensions are intended to provide income in retirement. While we know people have used them for planning for the next generation, if you’re thinking about passing down the generations – in my view, pensions should be the last thing you touch,” she says.
For all these scenarios legal advice is highly recommended – ideally sitting alongside financial advice if that’s possible.
Paul Gotch is senior partner at Private Client Solicitors. He says by nature a pension will be held in trust, subject to scheme rules, depending on the individual policy. All anyone really has the power to do is change their expression of wish, or nomination form, which tells the trustee who should receive it on their death. The trustee should take that guidance but they’re not legally binding.
Think about how you’re splitting things. Does the spouse get the pension and any children get other assets? Are you splitting things 50/50? Have you got other children with the new spouse?
“You need to balance the legal perspective – what you can do, with the financial perspective – what is fair. Are you leaving your spouse sufficient funds to maintain their standard of living, the cost of the property and so on,” says Gotch.
“Equally, if assets go to that surviving spouse, there’s a risk that on his or her death, they update the will and nomination to only include his or her own children, which then creates the disinheritance of the first.”
Think about care costs as well. It’s very common when a relationship is going well and is full of trust, that the surviving spouse will ‘do the right thing’ but circumstances change.
What if they’ve not fallen out with your children but they needed several years of expensive care, asks Gotch. They planned to pass on the remaining assets as their spouse intended but by the time they die, these might have been significantly depleted.
Ultimately, there isn’t a trust structure that can eliminate every risk. Family circumstances evolve, relationships change and intentions can be misunderstood. But for blended families facing a more complex IHT landscape, taking time to put clear plans in place may help prevent disputes and uncertainty later on.
